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IC 8979 



Bureau of Mines Information Circular/1984 




Mergers in the Nonfuel Minerals 
Industry: Trends and Motives 

By James S. Grichar and Elizabeth H. Yaremchuk 



UNITED STATES DEPARTMENT OF THE INTERIOR 



Information Circular 8979 



[ 



Mergers in the Nonfuel Minerals 
Industry: Trends and Motives 



By James S. Grichar and Elizabeth H. Yaremchuk 




UNITED STATES DEPARTMENT OF THE INTERIOR 
William P. Clark, Secretary 

BUREAU OF MINES 
Robert C. Horton, Director 



As the Nation's principal conservation agency, the Department of the Interior 
has responsibility for most of our nationally owned public lands and natural 
resources. This includes fostering the wisest use of our land and water re- 
sources, protecting our fish and wildlife, preserving the environmental and 
cultural values of our national parks and historical places, and providing for 
the enjoyment of life through outdoor recreation. The Department assesses 
our energy and mineral resources and works to assure that their development is 
in the best interests of all our people. The Department also has a major re- 
sponsibility for American Indian reservation communities and for people who 
live in Island Territories under U.S. administration. 






Library of Congress Cataloging in Publication Data: 



Grichar, James S 

Mergers in the nonfuel minerals industry. 

(Information circular / Bureau of Mines ; 8979) 

Bibliography: p. 13 

Supt. of Docs, no.: I 28.27:8979. 

1. Nonfuel minerals industry— United States— Consolidation. I. 
Yaremchuk, Elizabeth H. II. Title. III. Series: Information circular 
(United States. Bureau of Mines) ; 8979. 



TOe&guil^ [HD9506.U62] [338.8'3622'09731 84-600026 



For sale by the Superintendent of Documents, U.S. Government Printing Office 
Washington, D.C. 20402 



CONTENTS 

Page Page 

Abstract 1 Role of energy companies 7 

Introduction 1 Value of assets acquired in mining and 

Characteristics of mergers in the nonfuel mining mineral mergers 8 

and minerals industry, 1960-79 3 Motives for mergers 9 

Data source and limitations 3 Merger-conglomerate theory 9 

Nonfuel mining and mineral industry Merger motive tests 10 

mergers, 1960-79 3 Relative earnings volatility hypothesis 10 

Sample groupings 4 Earnings growth hypothesis 10 

Periods of merger activity, 1960-79 4 Replacement cost hypothesis 11 

Types of firms merged 6 Summary 12 

Case 1 6 References 13 

Case 2 7 

Case 3 7 

ILLUSTRATIONS 



-v 



si 



1. Number of manufacturing and mining firms acquired, 1895-1978 2 

2. Index of merger activity, 1960-79 4 

3. Percent of mining and mineral firm mergers, by case, cumulative 5 

4. Number of mining and mineral firm mergers, by case 5 

5. Value of assets acquired in mining and mineral firm mergers, actual and constant 1960 dollars 8 



U TABLES 

1. Total U.S. company mergers, manufacturing and mining firm mergers, and mining and mineral firm 

mergers, 1960-79 4 

2. Mining and mineral firm mergers, 1960-79 4 

3. Mining and mineral firm mergers during four periods of merger activity, 1960-79 4 

4. Matrix of mergers by industry area of acquired and acquiring companies, case 1, 1960-79 6 

5. Detailed breakdown of major groups that acquired primary metals firms, 1960-79 6 

6. Matrix of mergers by industry area of acquired and acquiring companies, case 2, 1960-79 7 

7. Detailed breakdown of manufacturing industries into which primary metals firms bought, 1960-79 7 

8. Matrix of mergers and acquisitions by industry area of acquired and acquiring companies, case 3, 1960-79 . . 7 

9. Purchase of mining and mineral firms by energy companies, 1960-79 7 

10. Number of energy companies acquired by mining and mineral firms, by period and SIC code, 1960-79 8 

11. Yearly asset acquisition in mining and mineral firm mergers 8 

12. Merger activity of large firms, 1960-79 9 

13. Relative earnings volatility hypothesis 11 

14. Earnings growth hypothesis 11 

15. Replacement cost hypothesis 12 



ri 







MERGERS IN THE NONFUEL MINERALS INDUSTRY: 
TRENDS AND MOTIVES 

By James S. Grichar 1 and Elizabeth H. Yaremchuk 1 




ABSTRACT 



Interest in mergers in the nonfuel mineral industry developed when 5 were listed 
among the 50 highest valued mergers in the United States in 1981. This report 
presents a Bureau of Mines study of trends in merger activity from 1960 to 1979 and 
explores motives for mergers in the nonfuel mining and mineral industry. The 
objective was to determine precedent for or a trend toward the 1981 acceleration in 
merger activity and to examine certain financial motives for nonfuel mineral mergers. 
Data indicate that the relative value of nonfuel mineral mergers has grown since 1972 
although the number of mergers has remained proportionate to historical trends for all 
mergers. Since 1974, the assets acquired in "large," nonfuel mineral firm mergers, 
those of $10 million or more, have comprised at least 93 pet of assets acquired. More 
nonfuel mineral firm mergers involved mineral companies as the acquiring firm than 
vice versa but mining and minerals firms acquired were of higher value than 
nonmining firms. A major motivation for mergers involving large mineral firms was 
the acquisition of assets at less than replacement costs. Univariate statistical testing, 
a methodology chosen for its applicability to the data, confirms this hypothesis while 
rejecting other financial motives. The remainder of the work is devoted to a discussion 
of suggested areas for future study. 



INTRODUCTION 



In 1981, five mergers involving nonfuel mineral firms 
took place, which together were valued at almost $7.5 
billion (i). 2 This development led to speculation that 
remaining independent mining and mineral firms — 
strapped by high interest debt, foreign competition, and 
historically low commodity prices, but in possession of 
potentially valuable in-ground resources — would soon 
succumb to merger bids. Some mineral experts believe 
this action would be the only way to preserve the domestic 
industry in that the acquiring companies will become a 
source of funds to mineral firms in need of investment 
capital. Others suggest the total submersion of the mining 
and mineral industry into companies in other fields will 
hasten the demise of the domestic industry, since mining 
and mineral investments often do not provide the return 
on investment of other product lines, and will not receive 
adequate funding. The debate between the two schools of 
thought may soon be academic, however, since for 
example, 7 of the 11 largest U.S. copper producers have 
been acquired in the last 20 years. On the other hand, 
companies such as U.S. Steel may have forestalled 
takeover attempts by becoming acquirers themselves. 

Mining and mineral companies have been at the 
forefront of the three "waves" in merger activity that 



' Economist, Division of Minerals Policy and Analysis, Bureau of Mines, 
Washington, DC. 

2 Italic numbers in parentheses refer to items in the list of references at 
the end of this report. 



occurred in the U.S. prior to 1979. Figure 1 shows the 
number of mergers each year for the 1895-1978 period. 
During the first peak in activity, which occurred at the 
turn of the century, U.S. Steel was established after a 
series of horizontal integrations. The second wave of 
merger and acquisition activity began just prior to the 
1920's, and peaked in 1928. During this period, mergers in 
the food processing, chemical, and mining sectors com- 
prised 60 pet of all merger activity; and extensive vertical 
integration in mining led to the founding of Kennecott, 
Anaconda, Phelps Dodge, Bethlehem Steel, and Republic 
Steel (2-3). 

The third merger wave began in the 1950's, although 
activity did not peak until the late 1960's and early 1970's. 
Unlike the earlier waves in which the principal result of 
merger activity was the consolidation of firms that 
produced related products, this period of accelerated 
merger activity was distinguished by corporate diver- 
sification into new product markets. Mining and mineral 
firms were often a target in these conglomerate mergers, 
but often, the opposite was true. The "Characteristics of 
Mergers in the Nonfuel Mining and Minerals Industry, 
1960-79" section of this report examines the extent of 
merger activity from 1960 through 1979 based on data 
obtained from the U.S. Federal Trade Commission (FTC). 
It covers the topic from several perspectives including 
volume, value, and the extent of nonfuel mining and 
mineral processing firm mergers in relation to all other 
mergers. It also seeks to determine what types of mining 



and mineral processing firms were connected with merger 
activity and other trends. 

The 1981 increase in merger activity induced specula- 
tion about the reasons for mergers and raised questions 
concerning the future viability of the domestic mineral 
industry. The "Motives for Mergers" section explores 
several financial motives for recent merger activity 
among eight large mineral firms, using data extracted 
from annual reports, and discusses possible areas of future 
research. 



This report does not examine the topic of foreign 
equity ownership of domestic mineral firms. The degree to 
which domestic mining and mineral firms have been 
acquired by foreign interests is unknown and difficult to 
trace. Two notable recent mergers are the Elf Aquitane 
(France) acquisition of Texasgulf in 1980 and the partial 
acquisition of Kennecott by British Petroleum through its 
majority ownership of Standard Oil (Ohio) in 1981. Data 
on foreign acquisitions are aggregated into data used in 
this study, but are not dealt with as separate issues. 



3.000 



2,000 



Q 
tu 

DC 

3 

a 
o 
< 

5 

<r 



O 

tr 

111 
03 

5 



1.000 



i — i — r 



t — i — r 



i — i — r 




i 



1896 1900 1906 1910 1915 1920 1926 1930 1936 1940 1946 1960 1966 1960 1966 1970 1975 1980 



YEAR 

Figure 1. — Number of manufacturing and mining firms acquired, 1895-1978. (Source: Malcolm S. Salter and Wolf A. Weinhold, 
DIVERSIFICATION THROUGH ACQUISITION: STRATEGIES FOR CREATING ECONOMIC VALUE. New York: The Free Press, a Division of Macmillan, 
Inc., 1979, p. 10.) 



CHARACTERISTICS OF MERGERS IN THE NONFUEL MINING AND MINERALS 

INDUSTRY, 1960-79 



Merger activity from 1960 to 1979 was marked by two 
separate developments. In the first, a rise in the volume of 
merger activity occurred. In the second, an increase in the 
value of mergers developed. Nonfuel mining and mineral 
industry mergers were a constant component of both 
developments. From 1966 to 1969 a wave of activity 
occurred where the number of mergers rose to two and 
three times prior activity. Nonfuel mining and mineral 
industry mergers closely tracked the trend in the volume 
of all mergers, comprising roughly 5 pet. They again 
followed the trend of overall mergers when from 1975 to 
1978 the total value of mergers accelerated to many times 
previous values. The primary purpose of this section is to 
describe trends in the volume and value in nonfuel mining 
and mineral mergers from 1960 to 1979, and the kind of 
firms and to what degree nonfuel mineral firms merged. 



DATA SOURCE AND LIMITATIONS 

From 1960 through 1979, the FTC collected informa- 
tion (4) on mergers and acquisitions in the mining and 
manufacturing industry for use in its publication. 
Statistical Report on Mergers and Acquisitions, which has 
been discontinued. The FTC staff relied on published 
reports in business and financial newspapers and journals 
for indications of merger activity. Merger reports were 
chronicled with the names of the two companies involved, 
their respective Standard Industrial Classification (SIC) 3 
codes, the asset value for each (when available), the date 
of merger, and other salient statistics. Although the FTC 
discontinued collecting this data in 1979, this data series 
was chosen because it was readily available, covered the 
longest time span, provided the most information, was 
computerized, and had merger data available by SIC code. 

The SIC code was used to limit the merger group 
sample to mining and mineral firms. The FTC used a 
four-digit SIC code to describe the major function of each 
company. The first two digits of a SIC code describe the 
"major group." All mergers were included that involved 
companies classified under major groups; metal mining 
(10), nonmetallic mining except fuels (14), primary metals 
(33), and all of the various subgroups of these major 
groups, plus asbestos products (3292). On this basis, the 
computer search arrived at 1,684 observations. 45 

There are several limitations inherent in the data. 
There is the question of the completeness: ( 1 ) the FTC may 
not have catalogued all reported and published mergers, 
(2) the news media may not have covered all mergers 
because of the space made available to print information 
and its newsworthiness, and (3) most transfers of 
privately owned companies probably would not be 



3 The SIC defines an industry in terms of product or function. The code 
was developed by the Office of Management and Budget lOMBi to promote 
the comparability of statistics. 

* In The Standard Industrial Classification Manual, a two-digit code 
denotes a major group. A three-digit code is an industry group. A four-digit 
code is a specific industry. 

5 A comprehensive listing of mining and mineral firm mergers 1 1960-79) 
is available upon request from the authors. 



publicized. It has been assumed for this report, however, 
that all large, significant mergers are included in the 
data. 

Another limitation involves the use of obsolete or 
inaccurate SIC codes. Since 1960, the SIC codes have been 
revised on several occasions, usually to consolidate 
subgroupings, occasionally to add a new subgroup. In 
aggregate SIC statistics, however, code revisions rarely 
redefine an industry's (and therefore a firm's) classifica- 
tion from one major group to another. Because the sample 
group was based on the major groups, not the subgroups, 
this should not pose a significant limitation to the data. 

A more significant problem with SIC codes concerns 
the larger or conglomerate companies that are active in 
many aspects of commerce and trade. It is meaningless to 
use a single SIC code for a conglomerate firm, but it is 
done. It is possible, therefore, that a large mining and 
mineral interest may have been excluded from the sample 
because the single SIC code applied to the company may 
have been outside the realm of mining and mineral 
activity. For example, conglomerate firms with mining 
and mineral activity in the company portfolio may be 
recorded under the major group wholesale trade — durable 
goods (50) or the major group holding companies (67). It 
was not possible to determine to what extent this may 
have affected the sample. 

Finally, asset data were sparse, especially in the early 
years of data, and asset data are always questionable. The 
size of a merger was determined on the basis of assets 
listed for the acquired company. While only 349 of the 
1,684 mergers reviewed contained an asset value for the 
acquired company, for the most part the asset values 
available were for the largest mergers. Therefore, 
although only 20 pet of mergers report asset value, the 
total of all values reported approaches 100 pet of all assets 
acquired. The limitations of the FTC data are not 
uncommon for this sort of data, however they are 
assumed, at the very least, to be representative of the 
major trends in merger activity. 



NONFUEL MINING AND MINERAL INDUSTRY 
MERGERS, 1960-79 

Figure 2 displays an index of the number of (1) all 
mergers in the U.S. between 1960 and 1977, (2) 
manufacturing and mining mergers from 1960 through 
1977, and (3) nonfuel mining and mineral processing 
(M&MP) mergers from 1960 through 1979. Indexing 
facilitates a comparison of the trends of the three groups. 
M&MP mergers have generally followed the overall trend 
in merger activity since 1960. All merger activity declined 
slightly until 1966 and then sharply accelerated until 
1970, after which the number of mergers j er year fell off 
sharply. Throughout the period, M&MP mergers 
accounted for a fairly constant proportion of mergers in 
the economy. In comparison with all mergers in the U.S. 
during this period, the share that involved M&MP firms 
averaged only 4 pet (table 1). M&MP mergers averaged 
approximately 8 pet of mergers in all the manufacturing 
and mining category. 



> 
I- 
o 
< 

IT 
UJ 

O 
a. 



o 

X 

UJ 

o 

z 



500 



400 



300 



200 



100 



I I I I | I I I I | I I I I | M I I 

KEY 
— ^— All mergers 
----- All manufacturing and 
mining mergers 

— All mining and mineral — 

processing mergers 
Baseline: 1960 = 100 




1960 



1965 



1975 



1970 
YEAR 

Figure 2. — Index of merger activity, 1960-79. 



1980 



Table 1. — Total U.S. company mergers, manufacturing and 
mining firm mergers, and mining and mineral 
firm mergers, 1960-79 



Total 



Manufacturing 
and mining 



Mining and 
mineral 



1960 
1961 

1962 . 

1963 . 

1964 . 

1965 . 

1966 . 

1967 . 

1968 . 
1969 

1970 
1971 
1972 
1973 
1974 

1975 
1976 
1977 
1978 
1979 





Total 


pet 1 


Total 


pet 1 


1.345 


844 


62.8 


74 


5.5 


1,724 


954 


55.3 


88 


5.1 


1,667 


853 


51.2 


86 


5.2 


1,479 


861 


58.2 


79 


5.3 


1,797 


854 


47.5 


89 


5.0 


1,893 


1,008 


53.2 


63 


3.3 


1,740 


995 


57.0 


57 


3.3 


2,384 


1,496 


52.8 


91 


3.8 


3,932 


2,407 


61.2 


137 


3.5 


4,542 


2,307 


50.8 


144 


3.2 


3,089 


1,351 


43.7 


139 


4.5 


2,633 


1,011 


38.4 


86 


3.3 


2,839 


1,036 


36.5 


92 


3.2 


2,359 


1,275 


54.0 


87 


3.7 


1,474 


909 


61.7 


79 


5.4 


1,047 


578 


55.2 


43 


4.1 


1,171 


692 


59.1 


67 


5.7 


1,182 


483 


40.9 


66 


5.6 


NA 


NA 


NA 


58 


NA 


NA 


NA 


NA 


59 


NA 



Total 38,303 



NAp 



1,684 



NAp 



NA Not available. NAp Not applicable. 
' Of all U.S. company mergers. 

Source: Computed from data from U.S. Federal Trade Commission, Bureau 
of Economics, Report on Mergers and Acquisitions, Dec. 1978. and 
unpublished data. 



Sample Groupings 

M&MP firms can be involved in a merger in various 
ways. First, an M&MP firm may be acquired, either by a 
non-M&MP firm or by another M&MP firm (cases 1 and 3 
of table 2). On the other hand, an M&MP firm may be the 
one acquiring either a non-M&MP firm or another M&MP 
firm (cases 2 and 3 of table 2). From 1960 through 1979, 
FTC data indicate non-M&MP firms acquired 504 M&MP 
firms, M&MP firms acted to acquire 920 non-M&MP 
firms, and there were 260 mergers among M&MP firms. 

M&MP firms were the acquiring firm (case 2) in 55 
pet of M&MP mergers and were the acquired firm (case 1) 
in about 30 pet of the total. In 15 pet of the mergers, both 
the acquiring and the acquired firm were M&MP 
companies. Figure 3 illustrates the changing percentage 
share of total mergers by case for the 1960-79 period. The 
percentage share of mergers in which M&MP firms were 
acquired by nonmining firms remained relatively stable 
throughout the period, while the percentage share of 
mergers by M&MP firms increased. The share of mergers 
in which both participants were M&MP firms dropped 
over the period. 

Table 2. — Mining and mineral firm mergers, 1960-79 





Case 






Fi 


rm 




Mergers 






Acq 


uiring 


Acq 


uired 




1 




Nonmi 
Mining 
do ... 


ling 
and 


and mineral 
mineral .... 


Mining and 
Nonmining 
Mining and 


mineral .... 
and mineral 
mineral .... 


504 


2 

3 




920 
260 



Periods of Merger Activity, 1 960-79 

Figure 4 charts the number of mergers per year by 
case. Four major periods of merger activity involving 
M&MP firms between 1960 and 1979 are indicated: 
1960-67, 1968-70, 1971-74, and 1975-79. From 1960 
through 1967, M&MP firms were acquired in 203 mergers 
by non-M&MP firms, acquired non-M&MP firms in 291 
mergers, and comprised both parties in 133 instances. The 
total number of mergers for the period was 627 and the 
average number per year was 78 (see table 3). 

The period of merger activity from 1968 through 1970 
showed a marked increase in the number of recorded 
mergers per year. For this 3-year period, the average 
number of mergers increased to 140 per year. The primary 

Table 3. — Mining and mineral firm mergers during four periods 
of merger activity, 1960-79 



Firm role 



Period 



Acquired, 
case 1 



Acquiring, 
case 2 



Acquired- 
acquiring, 
case 3 



TOTAL MERGERS 



1960-67 203 291 133 

1968-70 121 236 63 

1971-74 97 211 36 

1975-79 83 182 28 



627 
420 
344 
293 



Total .... 


504 


920 


260 


1,684 


AVERAGE MERGERS PER YEAR 


1960-67 


25 


36 


17 


78 


1968-70 


40 


79 


21 


140 


1971-74 


24 


53 


9 


86 


1975-79 


17 


36 


6 


59 



(A 

CC 



(3 

oc 



< 

oc 



5 

o 
z 
< 



oc 

< 
z 

(A 

Ul 

in 

< 




KEY 

Nonmining firm the acquiring; 
mining firm the acquired 



Mining firm the acquiring; 
nonmining firm the acquired 



Mining firm the acquiring; 
mining firm the acquired 



1960 1966 1970 1975 1979 

YEAR 

Figure 3.— Percent of mining and mineral firm mergers, by case, cumulative. 
150 



KEY 



(0 

OC 
UJ 

a 

oc 

UJ 

2 



oc 

UJ 

m 

2 

3 



100 — 



50 



I I I I I I I I II I I I I I 


1 1 1 


r'-' 7 ^''\ 




l'-' 1 ' '' -i 








/Case 1.'\ 




r i\\\ Nrt~"'A 




^O'l^^^'/A /r/H \ ; ' ; ''~-- ,v '-> 




,/?//w^'C'^v'A /;/ IIVfV'^>''-vA 








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-^V-.';Aw, 






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7C-'fi-A«§ 




TTT* 



Nonmining firm the acquiring; 
mining firm the acquired 



Mining firm the acquiring; 
nonmining firm the acquired 



Mining firm the acquiring; 
mining firm the acquired 



1960 



1966 1970 1975 1979 

YEAR 

Figure 4.— Number of mining and mineral firm mergers, by case. 



cause was an increase in acquisitions of nonmining 
properties by M&MP firms although there was also an 
increase in the yearly average of M&MP firms acquired. 
From 1968 through 1970, M&MP firms acquired 236 
nonmining firms. During the same period, 121 M&MP 
firms were acquired by non-M&MP firms, and there were 
63 mergers between M&MP firms. This peak period of 
merger activity in the M&MP industry was part of an 
overall wave of merger activity in the U.S. business 
community; however, the wave in M&MP merger activity 
continued 1 year longer (see figure 2). 

Between 1971 and 1974, the number of acquisitions 
reverted to prewave levels. Nonmining firms acquired 
M&MP firms in 97 instances, M&MP firms acquired 
nonmining firms in 211 instances, and there were 36 
mergers between M&MP firms. The level of activity of 
M&MP firms acquiring non-M&MP properties, however, 
remained higher, with an average of 53 per year, than the 
prewave level of 36 per year. Mergers between M&MP 
firms dropped below prewave levels from 17 during the 
average year to 9 per year. The number of acquisitions of 
M&MP firms by non-M&MP firms reverted almost exactly 
to prewave levels. 

The last period, 1975-79, showed a further decline in 
merger activity. Only 293 mergers involving M&MP firms 
took place during the period, with an average of 59 per 
year. Mining firms acquiring nonmining properties still 
accounted for the largest proportion of activity with 182 
mergers, followed by 83 mergers in which M&MP firms 
were acquired by nonmining firms. There were a total of 
28 mergers between M&MP firms during the period. The 
yearly average number of mergers between M&MP firms 
dropped to 6 per year while other averages dropped to 36 
per year for M&MP firms acquiring non-M&MP com- 
panies and 17 where M&MP firms were acquired by 
non-M&MP companies. 

Types of Firms Merged 

Although mergers in the nonfuel minerals industry 
generally followed the cyclical trend of all mergers from 
1960 to 1979, the trend in the type of merger in which 
M&MP firms participated was not the same. Overall 
merger activity experienced a shift away from horizontal 
and vertical mergers toward conglomerate mergers, while 
most of M&MP mergers were the result of diversification 
and vertical integration. When M&MP firms merged with 
other M&MP firms, it was most often between firms in the 
same industry group. 

Case 1 

M&MP firms were acquired by nonmining firms 
classified under the following nine SIC divisions: agricul- 
ture, fuel minerals, construction, manufacturing, trans- 
portation, wholesale trade, retail trade, finance, and 
services. Table 4 contains a matrix of mergers classified 
under case 1. M&MP firms were acquired by manufactur- 
ing firms in 331 or 66 pet of the mergers. Fuel mineral 
firms and service companies represented 38 and 36 
mergers respectively, or 15 pet of the total. 

Of the three types of M&MP firms, primary metal 
firms were acquired at a significantly higher rate than 
metal mining or nonmetallic mineral firms. Acquisitions 
of primary metals represented 71 pet or 360 of case 1 
mergers. Furthermore, the bulk of merger activity 



Table 4. — Matrix of mergers by industry area of acquired and 
acquiring companies, case 1, 1960-79 





Major SIC industry group 


of acquired 




SIC division 




company 




Total 


of acquiring 


10, 


14, 3292, 


33, 




company 


metal 


nonmetallic 


primary 






mining 


minerals 


metals 




A — Agriculture, forestry, 












1 








1 


B — Mining (fuel minerals) . . 


20 


4 


14 


38 


C — Construction 





10 


3 


13 



D — Manufacturing, except 

primary metals 

industries 16 

E — Transportation, 

communications 

F — Wholesale trade . . . 

G— Retail trade 

H — Finance, insurance, 

and real estate 

I — Services 

Unknown 

Total 51 



259 



331 



4 


1 


6 


11 


1 


2 


17 


20 





1 


3 


4 


2 


4 


4 


10 


3 


10 


28 


41 


4 


5 


26 


35 



93 



Table 5.— Detailed breakdown of major groups that acquired 
primary metals firms, 1960-79 

Major manufacturing SIC industr V 9 r ° u P of a ^ ui , red P rimar * 

industry group of metals company' J(M 

acquiring company 331 332 333 334 335 336 339 

28— Chemicals 5 3 4 2 6 2 2 24 

30— Rubber and plastics 2 1 1 3 1 8 

32 — Stone, clay, glass, 

and concrete 1 1 1 1 1 2 7 

34 — Fabricated metal 

products 13 10 3 12 4 6 48 

35 — Nonelectrical machinery . 11 15 1 1 10 4 8 50 

36— Electrical machinery .... 6 6 18 11 16 57 
37 — Transportation 

equipment 2 9 1 1 4 5 3 25 

38— Instruments 1 3 3 5 4 16 

Total 40 46 11 7 57 33 41 235 

1 See table 7 for definition of industry groups. 

NOTE: — The matrix details only those mergers where companies classified 
under the same industry group frequently targeted primary metals firms for 
acquisition. For this reason 24 acquisitions of primary metal companies do not 
appear in this table. 



occurred between manufacturing firms and primary metal 
firms. This included 259 mergers or 51 pet of the total. 

Of those 259 mergers, the majority of the acquiring 
firms were classified under eight major manufacturing 
industry groups and accounted for 235 mergers. Table 5 
shows the detailed matrix of this predominant activity. 
Primary metal firms were acquired principally by firms 
that are downstream consumers of mineral products, 
especially metals. To a lesser extent primary metal firms 
were also acquired by firms within major groups that are 
downstream consumers of minerals, especially nonmetal- 
lics. Technology transfer and economies of scale may have 
contributed to the decision by these types of firms to 
acquire primary metal firms. Additionally, a degree of 
legal vertical integration may have contributed to any 
decision process. 



Case 2 

M&MP firms acquired nonmining firms from a wide 
variety of fields. As with mergers in case 1, companies 
operating in fields in which there was some degree of 
technological transfer or vertical integration were the 
most likely candidates for acquisition. Table 6 provides a 
matrix of merger activity for case 2. M&MP firms 
acquired companies in agriculture, fuel mining, construc- 
tion, manufacturing, wholesale trade, retail trade, 
finance, and services. As with case 1, the bulk of activity 
occurred between primary metal firms and manufacturing 
firms, who are downstream consumers of minerals, 
metals, and nonmetallics. 

Table 7 provides a detailed breakdown of the chief 
manufacturing industries into which primary metals 
firms bought. A total of 433 mergers, 47 pet of mergers in 
case 2, took place between primary metals firms and nine 
manufacturing groups. Firms engaged in producing 
fabricated metal products and machinery, either electrical 
or nonelectrical, were primary targets. 



Table 8. — Matrix of mergers and acquisitions by industry area 
of acquired and acquiring companies, case 3, 1960-79 





Major 


SIC industry group of acquired 




Major SIC industry 




company 






group of acquiring 


10, 


14, 


3292, 


33, 


Total 


company 


metal 


nonmetallic 


asbestos 


primary 






mining 


minerals 


products 


metals 




10 — Metal mining . 


36 


4 





17 


57 


14 — Nonmetallic 












minerals 


1 


11 





2 


14 


3292— Asbestos 












products 








1 


2 


3 


33— Primary 












metals 


11 


3 


1 


171 


186 


Total 


48 


18 


2 


192 


260 



between M&MP firms. Two-thirds of the 260 mergers 
were between primary metal firms. Mergers between 
metal mining firms accounted for 14 pet, while mergers 
among nonmetallic firms comprised 4 pet of case 3 
mergers. 



Table 6. — Matrix of mergers by industry area of acquired and 
acquiring companies, case 2, 1960-79 

Major SIC SIC division of acquired company' 

industry group of Total 

acquiring company A B C D F G H I Unknown 

10— Metal mining 19 4 52 12 1 6 6 30 130 

14, 3292— 

Nonmetallic minerals .1 3 4 40 5 4 1 2 15 75 

33— Primary metals 15 9 48175 10 19 19 87 715 

Total 1 37 17 573 92 15 26 27 132 920 

' See table 4 for definition of divisions. 



Table 7. — Detailed breakdown of manufacturing industries into 
which primary metals firms bought, 1960-79 



SIC industry group of acquiring 
company 



Ma|or manufacturing industry 
group of acquired company' 

28 30 32 34 35 36 37 38 39 



■Total 



331— Blast foundries 19 8 10 61 29 12 5 4 5 153 

332 — Iron and steel 

foundries 4 9 6 19 19 8 7 5 77 

333— Nonferrous metals 4 1 313610 6 1 44 

334 — Secondary nonferrous 

metals 1 4 1 1 2 9 

335 — Rolling and drawing of 

nonferrous metals 6 9 6 1218 24 5 2 2 84 

336— Nonferrous foundries 1 3 42 3 4 1 18 

339— Miscellaneous industries 12 3 8 21 6 4 2 1 48 

Total 35 30 31 121 96 64 33 14 9 433 

' See table 5 for definition of industry groups. Industry group 39 is 
miscellaneous manufacturing industries. 



Case 3 

As a means to prevent the creation of large 
oligopolistic firms, antitrust legislation has curtailed 
mergers between firms that produce similar products. 
However, 84 pet of M&MP firms that merged were in the 
same industry group. Table 8 provides a matrix of mergers 



ROLE OF ENERGY COMPANIES 

Fuel mineral mining firms and petroleum processing 
firms (energy companies) have been prominently involved 
in M&MP merger activity since 1979. Analysts perceived 
that the purchase of M&MP firms was a new and 
pervasive move on the part of oil companies but the 
empirical evidence does not support this. Energy firms 
acquired M&MP firms throughout the 1960-79 period. 
Table 9 shows the pattern of acquisition of M&MP firms 
by energy companies over the 1960-79 period. It includes 
SIC major group 13, oil and gas extraction, and SIC major 
groups 11, 12, and 29, which are, respectively, anthracite 
mining, bituminous coal and lignite mining, and pet- 
roleum refining. Together these major groups represent 
"energy companies," and represent 9.1 pet of case 1 



Table 9. — Purchase of mining and mineral firms by energy 
companies, 1960-79 

SIC code 1960-67 1968-70 1971-74 1975-79 Total 

1111— Anthracite mining 2 2 

1211 — Bituminous coal 
and lignite 2 1 1 4 

131X — Crude petroleum 
and natural gas 10 6 3 8 27 

1381— Drilling oil 
and gas wells 1 1 

1382— Oil and gas- 
field exploration 
services 2 2 

1389 — Oil and gas- 
field services 1 1 

1 39X — Miscellaneous 
oil and gas 1 1 

2911— Petroleum re- 
fining 2 2 1 2 7 

295X— Paving and 
roofing materials 1 1 

Total 20 9 6 11 46 



Table 10.— Number of energy companies acquired by mining 
and mineral firms, by period and SIC code, 1960-79 

SIC code 1960-67 1968-70 1971-74 1975-79 Total 

1111— Anthracite mining .... 1 1 

121X — Bituminous coal 
and lignite mining 3 3 

1211 — Bituminous coal 
and lignite 2 4 4 5 15 

131X — Crude petroleum 
and natural gas 6 4 3 2 15 

1381— Drilling oil 
and gas wells 1 1 

1382— Oil and gas- 
field exploration 
services 1 1 2 

291 1— Petroleum re- 
fining 1 1 

2952— Asphalt felts 
and coatings 1 1 

Total 9 9 13 8 39 



mergers. A review of table 9 shows that from 1960 to 1979 
a total of 46 mergers of this type transpired. The pace of 
acquisition was approximately constant over the period, 
with more mergers occurring from 1960 to 1970 than 
afterward. 

M&MP firms have acquired almost the same number 
of energy companies as have energy companies acquired 
M&MP firms. Table 10 shows the breakdown by period. 
M&MP companies most often bought coal firms or crude 
petroleum firms. Acquisitions occurred throughout, but 
peaked from 1968 to 1974. 



VALUE OF ASSETS ACQUIRED IN 
MINING AND MINERAL MERGERS 

The trend in the value of assets acquired in M&MP 
mergers contrasts with the trend in the volume of 
mergers. Data available to 1979 show the value of 
purchases of mineral assets began to escalate in the 
mid-1970's but did not peak until 1978, 9 years after the 
peak in the volume of mergers occurred. Table 11 shows 
the total value of assets acquired by year and by case in 
millions of dollars. It reveals that in dollar terms 
relatively little merger activity occurred until the 1970's. 
After total values began to increase in 1972, the total 
assets acquired in a year quickly reached billion-dollar 
levels. In 1978, purchases of M&MP companies by 
nonmining companies totaled almost $7 billion. The value 
of purchases by M&MP firms increased during the period 
as well, but by a smaller degree. Although M&MP firms 
were more active in purchasing non-M&MP companies 
than vice versa, the value of M&MP assets absorbed by 
nonmining companies were several times larger than 
nonmining company assets absorbed by M&MP compa- 
nies. 

From 1960 to 1979 the price index more than doubled, 
which suggests that in constant money terms the recent 
surge in activity might be a function of inflated values. 
This is not entirely so. Figure 5 shows the total value of 
assets acquired yearly in actual dollars and in constant 
1960 dollars. It shows that even in real terms a 
pronounced increase in asset acquisition, took place 
beginning in the mid-1970's. 

Part of the cause for the increase in asset acquisition 



Table 11. — Yearly asset acquisition in mining and mineral 
firm mergers, million dollars 



Q 
ID 

rz 

o 

a 
o 
< 



CO 
CO 

< 



Case 1 , mining Case 2, mining C . ase 3 ' mini " 9 

firm acquired, firm acquiring, 920 irm acqu "!*°' 

,-„,, i3' acquirinq, 260 

504 mergers mergers ^ y ' 

3 a mergers 



Total 



1960 $2.3 

1961 19.7 

1962 12.0 

1963 31.8 

1964 2.6 

1965 15.5 

1966 .3 

1967 3.8 

1968 10.0 

1969 28.8 

1970 13.0 

1971 7.3 

1972 157.3 

1973 57.7 

1974 541.6 

1975 55.2 

1976 3,589.7 

1977 4,560.9 

1978 6,893.3 

1979 981.8 

Total 16,984.6 



$0.1 
75.9 

1.7 
4.0 
3.7 

4.3 
1.1 
6.0 
1.5 
11.1 

79.9 

3.2 

145.1 

220.9 

466.0 

92.9 
602.5 

1,582.7 
644.7 

1,458.0 



$32.0 


$34.4 


1.1 


96.7 


34.1 


47.8 


37.9 


73.7 


11.7 


18.0 


6.3 


26.1 


.1 


1.5 


2.5 


12.3 


1.1 


12.6 


1.5 


41.4 


27.6 


120.5 


3.3 


13.8 


19.5 


321.9 


69.3 


347.9 


95.2 


1,102.8 


158.3 


306.4 


256.9 


4,449.1 


30.9 


6,174.5 


.0 


7,538.0 


37.7 


2,477.5 



5,405.3 



827.0 



23,216.9 



I I I I I I I I I I I I I I I I I 



KEY 



Total assets acquired 
Total assets acquired 
1960 dollars 




1960 



1965 



1975 



1980 



1970 
YEAR 

Figure 5. — Value of assets acquired in mining and mineral 
firm mergers, actual and constant 1960 dollars. 



Table 12. — Merger activity of large firms, 1 1960-79 



Acquisitions 



Year 



M&MP firms as a 
percentage of 



Value of assets, million dollars 



Assets of large 
M&MP firms as a 



Manufacturing and Mining and mineral manufacturing and Manufacturing and Mining and mineral P ercen a 9 e ° ar 9 e 
mining mining mergers mining manufacturing and 

3 3 3=> mining mergers 



1960 51 1 0.2 $1,535.1 $29.3 1.9 

1961 46 3 6.5 2,003.3 72.7 3.6 

1962 65 1 1.5 2,251.3 14.0 .6 

1963 54 4 7.4 2,535.8 60.5 2.4 

1964 73 2,302.9 .0 .0 

1965 64 1 1.6 3,253.7 14.5 .4 

1966 76 3,329.1 .0 .0 

1967 138 8,258.2 .0 .0 

1968 174 12,580.0 .0 .0 

1969 138 2 1.4 11,043.2 33.4 .3 

1970 91 3 3.3 5,904.3 86.9 1.5 

1971 59 2.459.9 .0 .0 

1972 60 8 13.3 1,885.5 265.6 14.1 

1973 64 8 12.5 3.148.8 310.2 9.9 

1974 62 9 14.5 4.466.4 1,054.5 23.6 

1975 59 6 10.2 4,950.5 286.2 5.8 

1976 81 22 27.2 6,279.2 4,406.0 70.2 

1977 99 20 20.2 8,669.9 6,155.9 71.0 

1978 NA 14 NA NA 7,514.5 NA 

1979 NA 18 NA NA 2,473.6 NA 

NA Not Available. 

' Firms with assets of $1 million or more. Includes all mergers that involved mining and mineral firms regardless of role in merger (whether acquiring or acquired). 

Source: U.S. Federal Trade Commission, Bureau of Economics, Report on Mergers and Acquisitions, Dec. 1978, and unpublished FTC data. 



was the purchase of several very large mineral companies 
during the late 1970's. Even so, the average merger was 
getting larger. Large mergers were defined as those 
mergers in which the assets of the acquired company were 
worth $10 million or more. From 1960 to 1972 the assets 
acquired in large mergers comprised anywhere from 0.0 
pet to 85.2 pet of all assets acquired in a year. Since 1974 
the assets acquired in large mergers comprised at least 93 
pet, and from 1976 to 1979, 99 pet of the total assets. 



The increase in the number or value of M&MP 
mergers may have crowded out merger activity in other 
industries. Table 12 lists the merger activity of large firms 
from 1960 to 1979. As the number of large mergers 
increased each year and the total value of assets acquired 
swelled, M&MP mergers accounted for a larger share of 
yearly merger activity. In 1977 the value of M&MP assets 
acquired comprised over 70 pet of all large manufacturing 
and mining mergers. 



MOTIVES FOR MERGER 



There are many possible motives that can be used to 
explain corporate mergers. An understanding of which 
appear to be most important in mergers may provide an 
improved basis for ultimately evaluating the impact of 
mergers on the economy and on the U.S. mining industry 
in particular. 

This section provides a brief review of merger- 
conglomerate theory and then discusses an analysis of 
statistical tests for specific motives underlying mergers in 
the mining and minerals industry. 



MERGER-CONGLOMERATE THEORY 

Economists, finance theorists, and industrial orga- 
nization experts have analyzed and debated merger- 
conglomerate theory for decades. Discussions of the 
advantages and disadvantages of such complex organiza- 
tional structures and how such structures were put 



together led to analyses of the motives behind mergers 
and conglomerate combinations. For purposes of this brief 
discussion of merger theory, the exposition will be 
simplified by separating theories into two schools of 
thought. 

The first school of thought believes that mergers are 
generally a benefit both to the acquired firm's stockhold- 
ers — who are usually paid a premium over the market 
price for their stock — and to the acquiring firm's stock- 
holders because diversification reduces the overall costs 
of doing business. Oliver Williamson, a noted industrial 
organization theorist, has analyzed the evolution of the 
corporation (5). He believes that the modern multidi vision 
firm, run by a general management group, is interested in 
maximizing profits. In the single-division firm, William- 
son believes that managers do not maximize profits and 
instead pursue other goals such as maximizing sales and 
executive amenities, increasing market shares, and other 
goals that may not necessarily lead to maximum profits. 



10 



Williamson concludes that conglomerate mergers are a 
way of reducing the transaction costs of conducting 
business and are thus beneficial to stockholders, in terms 
of increased profitability, and to society, in terms of 
increased efficiency in use of resources. The theory of 
reducing transaction costs subsumes several motives for 
merger, for example economies of scale in production or 
consumption of products or services, etc. (6). 

The other major theory of mergers and conglomera- 
tion takes the opposite view. In this theory, single-division 
firms are more efficient. Managers undertake mergers in 
order to reduce downward fluctuations in corporate profits 
and thus assure that their salaries and bonuses, which are 
tied to profits, are subject to less downside risk. Because 
most stockholders can attempt to reduce risk by diversify- 
ing their own portfolios, the conclusion resulting from this 
theory is that mergers are not necessarily in stockholders' 
best interests. Under this theory the economy does not 
benefit from mergers because the loss of competition 
results in less efficient use of resources (7). 



MERGER MOTIVE TESTS 

The following three hypotheses were tested as 
motives for mergers: 

1. Mergers occur to reduce the relative earnings 
volatility. 

2. Mergers will improve earnings growth. 

3. Assets are purchased because they are less 
expensive than if bought new today. 

In large and complex corporate structures, mergers 
may be motivated by multiple factors, or by different 
groups of factors, for each potential merger. However, by 
testing the motives separately, it can be determined 
whether viewing any of the three stated motives as an 
overriding factor is consistent with the data. To this end, 
univariate procedures were adopted in developing statis- 
tical tests for the three hypotheses. 6 In addition, analyses 
were designed to test mergers collectively rather than 
individually to determine motives for nonfuel mergers in 
the mining and mineral industry as a whole. 

The procedures used follow the general rules of 
statistical hypothesis testing. First the hypothesis to be 
tested is stated. It is called the null hypothesis, because it 
normally tests a zero difference between two populations. 
Second, a level of significance is chosen at which one is 
willing to risk rejecting the hypothesis if it is indeed true. 
This is called a type 1 error and was variously chosen here 
as 1, 5, and 7 pet. Third, the test statistic is calculated and 
compared to a standard value at the chosen significance 
(error) level. The stated hypothesis is accepted or rejected 
based on the comparison. If rejected, its alternative is 
usually stated and accepted but the same error level 
cannot be applied to the alternative. 

The following criteria for selection of the sample were 
applied: (1) at least one firm, either the acquiring or 
acquired firm, is a nonfuel mineral company, (2) at least 
one firm is a U.S. firm, (3) the merger took place during 
the 1977-82 period, a time when firms were reacting to 
inflation or perceived inflationary pressures, (4) the 



6 Small sample testing techniques are discussed in most basic statistics 
textbooks, see for example W. Mendenhall and J.E. Reinmuth, Statistics 
for Management and Economics, Duxbury Press, North Scituate, MA, 
1979. 



merger must have been completed — unsuccessful merger 
attempts were excluded, (5) the mergers must be 
considered large (defined as being among the 50 highest 
valued mergers in a given year) (1, 8), and (6) sufficient 
data were available from publicly available annual 
reports and/or 10K reports. Eight mergers were selected 
under the criteria. In all the statistical tests, the identities 
of the mergers are not given; they are represented by the 
letters of the alphabet. 

It was assumed that an acquiring firm's management 
would need data for 6 years prior to the merger to judge 
the most recent performance of the intended acquisition 
and to make judgments regarding expected future 
performance. Thus, in conducting the statistical tests, 6 
years of data prior to the merger were used. 

Relative Earnings 
Volatility Hypothesis 

The relative earnings volatility test examines the 
earnings stability of the acquiring firm and the acquired 
firm to determine whether or not if they had been merged 
for the 6 years prior to their merger their earnings would 
have been more or less volatile. A simple statistic called 
the coefficient of variation (COV) was used to conduct the 
test. The COV is the ratio of the standard deviation of 
earnings (a measure of the volatility of earnings) divided 
by the mean value of earnings and multiplied by 100 (to 
put it in percentage form.) Division by the mean value of 
earnings normalized earnings variability so that compari- 
sons among earnings volatility of different firms could be 
made. For the relative earnings volatility hypothesis, the 
COV of the acquiring firm's earnings was compared with 
the COV of the "combined firm's" earnings using earnings 
data for the 6 years prior to the actual merger. To obtain 
earnings for a combined firm, the two firm's earnings were 
added. Thus, it was assumed that the merger would have 
been in effect for 6 years. This procedure tested whether or 
not reduced relative earnings volatility was a merger 
motive. 

The null hypothesis for this test was that the COV of 
earnings for the combined firm was no different than the 
COV of earnings for the acquiring firm. Table 13 lists the 
COV's for the acquiring firm and the combined firm 
(assuming that the merger had been in effect during the 
previous 6 years so that the COV is comparable to the one 
computed for the acquiring firm). A paired difference test 
was conducted to see if there was a significant reduction in 
relative earnings volatility of the acquiring firm as a 
result of the combination. The paired difference is the 
average of all the differences (B-A). The standard 
deviation was computed and a t-test was conducted to see 
if the eight combinations reduced the relative earnings 
volatility. 

The results indicate that the null hypothesis cannot 
be rejected; that is, this test does not give support to the 
hypothesis that mergers in the nonfuel mineral industry 
were undertaken to reduce relative earnings volatility. 

Earnings Growth Hypothesis 

The earnings growth hypothesis test states that an 
acquiring firm bought another firm because the purchased 
firm had a faster earnings growth. The earnings growth 
rate for both the acquiring and acquired firm was 
computed by regressing after-tax earnings as an exponen- 



Table 13. — Relative earnings volatility hypothesis 

(Coefficient of variation of "combined" firm earnings was less than the coefficient of variation of acquiring firm earnings') 



Merger 
and 
date 



A, acquir- 
ing firm 
only 



B. com- 
bined 
firm 



Paired 
difference, 23 
B- A = d 



a, 1981 

b, 1981 

c, 1982 

d, 1979 



78 

29 

131 

23 



76 
30 
77 
22 



-2 

+ 1 
-54 

-1 



Merger 
and 
date 



A, acquir- 
ing firm 
only 



B, com- 
bined 
firm 



Paired 
difference, 23 
B-A = d 



e, 1981 

f, 1977 

g, 1981 
h, 1976 



35 
45 



16 



27 
84 
109 
22 



-8 
+ 39 

+ 1 
+ 6 



' Computed using earnings for the 6 years prior to merger. For combined firm, earnings of both firms are combined as if merger 
had been in effect for 6 years. 

2 Negative values are less volatile and positive values are more volatile. 

3 Paired difference test results — null hypothesis: combination did not reduce relative earnings volatility; n = 8, d = average of d 
for all firms in sample = -2.25. S d = 25.82, and to = d-0/(S/V n) = -2.25/(25.82. \ 8) = 0.2465. Null hypothesis is not rejected 
since -2.25 is not significantly different from at the 99-pct confidence level. Alternative hypothesis — earnings of the combined 
firm would have been significantly less volatile than those of acquiring firm — cannot be accepted. 



Table 14. — Earnings growth hypothesis 

(Acquiring firm bought acquired firm because acquired firm had faster earnings growth) 



Merger 
and date 



Firm annual earnings 
growth rate, pet 



A. ac- 
quiring 



B. ac- 
quired 



Paired 
differ- 
ence.' 
B-A 
= d 



a. 1981 

b. 1981 

c. 1982 

d. 1979 



28.2 
14 4 
323 
11.6 



15.0 
32.5 

147 
-12.1 



-13.2 
-18.1 
-17.6 
-23.7 



Merger 
and date 



Firm annual earnings 
growth rate, pet 



A. ac- 
quiring 



B, ac- 
quired 



Paired 
differ- 
ence.' 
B-A. 
= d 



e. 1981 

f. 1977 

g. 1981 
h, 1976 



18.3 

21.8 

59.1 

75 



28 

-51.1 

53.2 

33.7 



-15.5 

-72.9 

-5.9 

+ 26.2 



' Paired difference test results — null hypothesis: Earnings growth rates are equal: n = 8; d = average of d for all firms in sample 
= -13.06; S„ = 40.96: t„ = d-0 (S„ \ 8) = -13.06-0 (29 96 \ 8) - -0.902 Null hypothesis is not rejected because -0.902 is 
not significantly different from 0. Alternative hypothesis — acquiring firm purchased acquired firm because acquired firm had faster 
earnings growth — cannot be accepted. 



11 



tial function of time. 7 Once the earnings growth rates for 
merger partners were determined, a paired difference test 
was conducted for the eight very large mergers. The 
results indicated that the hypothesis of acquiring a firm 
because of higher earnings growth rates could be rejected 
for the sample group of mergers. Table 14 shows the 
results of this test. 

Replacement Cost Hypothesis 

Firms wishing to enter a specific market have to buy 
capital equipment, buildings, land, and, in the case of 
energy and mineral firms, land or developed properties 
that contain energy and mineral reserves and resources. 
Recent high rates of inflation, however, have caused the 
costs of entering new markets to rise sharply from one 
year to the next. Frequently, the inflationary rise has 
been greater than the increase in a firm's profits. Thus, it 
has been difficult for a firm to retain enough earnings to 
expand its business activity. On the other hand, many 
firms already in a specific business purchased assets 
before the recent major inflation. On corporate balance 
sheets, these assets have been valued at depreciated 
historic purchase costs. Thus, the true asset value of many 
firms has been understated on balance sheets because of 
inflation. 

The stock market and capital exchanges in the United 
States tend to value potential growth of near-term profits 



7 The functional form is E = a(e) bt , where E = earnings, a = intercept 
term, b = the compound annual growth rate, e = the base of the natural 
logarithm, and t = year. 



and not book values. During the recent high inflationary 
years, many firms in the nonfuel mining and mineral 
industry had profit growth rates below inflation rates. As 
a result, the stocks of many firms traded at a price that 
resulted in the total stock market value of the firm being 
at a level that was well below the book value of the firm or, 
even more prevalent and important, below the price that 
another firm would have to pay to duplicate an existing 
operation. 

In 1980 and 1981, investors, speculators, and mana- 
gers in energy and mineral firms felt that "assets in the 
ground" would provide the best hedge against inflation 
and that these assets could be most inexpensively 
obtained through merger with existing firms. The wave of 
mergers in the United States appeared to have been 
stimulated — at least in part — by the desire of acquiring 
firms to obtain an inflation hedge at substantially less 
than the normal, open market replacement cost value. 

The hypothesis was set up as follows: if acquiring 
firms were interested in purchasing other firms (existing 
assets are less expensive than the outright purchase of 
new assets), then the market price paid for the acquisition 
should be less than the replacement cost value of the 
acquired firm but more than the reported book value. To 
test this hypothesis, data for the firms were prepared as 
follows. First the fixed assets of the firm were separated 
from total assets and the depreciated values of the fixed 
assets were altered to reflect inflation's impact on asset 
values at the time of the merger. Next these asset values 
were multiplied by a price index to obtain the replacement 
cost of fixed assets for the acquired firm at the time of the 
merger. When nonfuel mineral firms were the acquisition 



12 



Table 1 5. — Replacement cost hypothesis 

(Price paid for acquisition is less than purchase price of new assets) 

Merger A, price B, book Paired C, book value Paired 

and paid per value per difference, 2 per share at difference, 3 

date share 1 share B-A = d, replacement cost C-A = d 2 

a, 1981 $33 $3 -30.00 $18. -15.00 

b, 1981 15 10 -5.00 22.50 +7.50 

c, 1982 103 35 -68.00 152 +49.00 

d, 1979 44 31 -13.00 82 +38.00 

e, 1981 52 22 -30.00 51 -1.00 

f, 1977 31 56 +25.00 97 +66.00 

g, 1981 62 57 -5.00 140 +78.00 

h, 1976 68 22 -46.00 40 -28.00 

' Cash price or equivalent in stock or bonds. 

2 Null hypothesis 1 : Price paid per share was equal to the book value per share; average of d, for all firms in sample = -21.5; 
So, = 28.5; Sg, = 10.08; t„, = -2.13. Reject null nypothesis 1 at 95-pct confidence level. Alternative hypothesis: Price paid per 
share was greater than book value. 

3 Null hypothesis 2: Price paid per share was equal to replacement cost value per share; d 2 = average of d 2 for all firms in 
sample = - 24.31 ; S„ 2 = 38.96; Sg 2 = 13; td 2 = 1 .77. Reject null hypothesis 2 at 93-pct confidence level. Alternative hypothesis 
2: Price paid per share was less than the replacement cost value. 



target, it was not possible to get an estimate of the value of 
reserves. Thus, the replacement cost value of these 
acquired firms as calculated will probably be understated. 
For oil and gas energy firms, Securities and Exchange 
Commission rules require the firms to publish estimates of 
the value of oil and gas reserves. These estimates were 
included for the oil and gas firms that were acquired and 
these figures were used to estimate the replacement cost 
values of fixed assets for such acquired firms. 

Once fixed asset values had been readjusted to 
estimate their current market replacement cost value, 
current assets were summed to obtain an estimate of the 
replacement cost value of all assets. Current liabilities 
and long-term debts were then subtracted from this total 
asset value to obtain an estimate of the firm's stockhold- 
ers' equity (book value), valued at current market 
replacement costs. It is this estimated value that can help 
indicate whether or not a firm followed the replacement 
cost hypothesis motive for acquiring another firm. 

Table 15 presents data on the price per share paid by 
the acquiring firm, the book value per share (or 



stockholders' equity per share), and the book value per 
share at current market replacement cost. Two types of 
paired difference tests were conducted. In the first test, the 
difference between the book value per share and the price 
paid per share was computed. Null hypothesis 1 stated 
that the price paid per share was equal to the book value 
per share. This hypothesis was rejected at a 95-pct 
confidence level, implying that significantly more than 
historical book value was paid. 

A companion test, null hypothesis 2, was conducted to 
see if the price paid was equal to the book value per share 
computed at current market replacement cost. This 
hypothesis was rejected at a 93-pct confidence level, 
implying that significantly less than estimated replace- 
ment cost was paid. The weaker conclusion of the second 
hypothesis is strengthened somewhat by the inability to 
include the estimated current market value of nonfuel 
reserves in the replacement cost calculation. Inclusion of 
the increase in the value of those assets would have 
increased the estimate of the replacement cost price per 
share. 



SUMMARY 



Tests reported in tables 13 and 14 fail to support the 
hypotheses that either the reduction of earnings volatility 
or the increase in the rate of earnings growth were major 
factors in large mining and mineral firm mergers. The 
tests reported in table 15 support the hypothesis that 
acquiring firms in mining and mineral firm mergers paid 
more than historical book value but less than the current 
market replacement costs of the assets of the acquired 
firm. 

The three tests do not constitute an exhaustive 
examination of merger motives. Other motives include a 
desire to expand corporate sales, earnings, product 
offerings, and services. Unfortunately they could not be 
tested in a rigorous manner owing to the lack of data. 
However, the valuation of firms by the stock market 
instead of the current market replacement cost value of 
the firm certainly appears to have contributed significant- 
ly to recent M&MP mergers. 



Given the simple statistical tests of motives for very 
large mergers used in this study, consideration might be 
given to expanding the scope of the tests to small- and 
medium-size mergers. Such tests could provide evidence 
as to whether or not the results obtained for very large 
mergers also apply to small- and medium-size mergers. 
However, the scarcity of detailed data for specific firms 
may prove to be as much of an obstacle to tests for these 
sizes of mergers as it was to tests of financial motives not 
treated in the tests reported here. 

The effects of mergers would also be a potentially 
good subject for hypothesis tests. In addition, there are 
several areas that might provide fertile ground for 
examination. For example, one factor that could be 
studied is the overall state of the economy relative to 
merger activity. Because of data limitations, this study 
does not incorporate macroeconomic considerations. 
However, a booming economy can make a poor merger 



13 



look good for a short time while a bad economy can make 
even the best merger look like a poor decision. A combined 
firm that performed well during a slack economy might be 
an indication that the merger has worked well, and vice 
versa. 

A firm's domestic production level could provide some 
implications as to the impact of a merger in the U.S. 
nonfuel mineral industry. If an acquiring firm's manage- 
ment demands a higher rate of return on its newly 
acquired subsidiary's operations, then some of the higher 
cost operations might be shut down. Of course, it is 
assumed that such a decision had taken into account the 
long-run potential of the operation and whether or not a 
reasonable investment of funds in new plant and 
equipment could raise profitability to desired levels. If it 
appeared that a previously independent mining company 
might have raised the capital for an investment to keep 
operations running profitably, and if the acquiring firm 
decided not to undertake an investment because it did not 
meet its higher profitability criteria, then one could 
conclude that the merger might have had a negative effect 
on the U.S. mining industry. Such a test would not be easy 
to conduct because some of the acquired firms are often in 
the position of not being able to raise capital to keep 
operations going, meaning that the investment would not 
have been made in either case. 

Another factor that could reflect the nature of the 
impact of mergers is whether or not there was a change in 
sales and distribution systems subsequent to a merger. 
For instance, if the acquiring firm determined that is 
could use the minerals (fixed assets) itself, this could upset 
the operations of other firms that previously depended on 
the merged firm for minerals supplied. As part of this 
concern, the degree of concentration at the supplier level 
and possibly the semifabricating or manufacturing level 
could be monitored for significant changes. 

Another very important factor is the level and 
distribution of investment. Subsequent to a merger, it is 
possible that investment in mining operations may 



increase but that these investments could be in new or 
existing overseas operations. Such a trend could suggest 
that the merger has had the effect of keeping domestic 
operations continuing until overseas opportunities could 
be pursued. It must be remembered that in many of the 
base metals, ore grades are higher overseas than in the 
United States. In addition, labor costs are probably much 
lower overseas. As a result, any trend toward greater 
overseas mining investment could well have occurred 
even if mergers had not taken place. Thus, interpretation 
of this factor would be subject to some qualifications. 

In addition, the level and distribution of exploration 
efforts could be monitored closely. If a merged firm made a 
major cut in domestic exploration or shifted exploration 
overseas, the long-term effect on U.S. minerals production 
could be negative. On the other hand, a sustained 
long-run commitment to domestic exploration — even if 
some domestic operations were shut down because of 
poor profitability — might indicate a longer term rebound 
or increase in U.S. mineral production. This is an 
extremely critical factor because it can take 10 to 30 years 
to discover a major deposit and another 10 years to 
develop a mine once the deposit has been sufficiently 
evaluated. 

Finally, another factor for consideration is the 
performance of the merged firm's stock relative to the 
market as a whole. An examination of this performance — 
compared with the stock market performance of the 
premerger acquiring and acquired firms — could indicate 
investor perceptions of the effects or impact of the merger. 
If postmerger relative performance appeared superior to 
both premerged firms, especially the mining firm, then the 
merger would be successful from the stockholder's view. 
The preceding factors, and others, could be used in 
tests of the effects of mergers on domestic minerals 
production. Until these types of factors are explored, the 
extent of information that can be obtained from company 
financial data is properly limited to testing for merger 
motives. 



REFERENCES 



1. Meadows, E. Deals of the Year. Fortune, Jan. 25, 1982, pp. 
36-40. 

2. Mueller, D.C. The Determinants and Effects of Mergers. 
Oelgeschlager, Gunn, and Hain, Inc., Cambridge, MA, 1980, pp. 
271-283. 

3. Salter, M.S., and W.A. Weinhold. Merger Trends and 
Prospects for the 1980's. U.S. Dep. Commerce, Dec. 1980, pp. 2-8. 

4. U.S. Federal Trade Commission. Previously unpublished 
data. A computer printout of the data is available upon request 
from J.S. Grichar or E.H. Yaremchuk, BuMines, Washington, 
DC. 



5. Williamson, O.E. The Modern Corporation: Origins, Evolu- 
tion, Attributes. J. Economic Literature, v. 19, Dec. 1981, pp. 
1537-1568. 

6. Scherer, F.M. Industrial Market Structure and Economic 
Performance. 2d ed., Houghton Mifflin Co., Boston, MA, 1980, pp. 
118-141. 

7. Amihud, Y., and B. Lev. Risk Reduction as a Managerial 
Motive for Conglomerate Mergers. Bell J. Economics, v. 12, No. 2, 
Autumn 1981, pp. 605-617. 

8. Steyer, R. Deals of the Year. Fortune, Jan. 24, 1983, pp. 
48-52. 



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